Border Adjustment Tax

By Kenneth H. Bridges, CPA, PFS     February 2017

President Trump has frequently made reference to imposing a tariff on imported goods, and Congress is now talking about enacting a “border adjustment tax”, also known as a “destination based cash flow tax”.  So what does this mean, who are the likely winners and losers, and what are the chances of this actually becoming law?

The current US income tax system is generally regarded as being anticompetitive, especially as pertains to multinational companies and goods and services which are exported rather than imported.  The current Federal corporate income tax rate is 35%, and we have what is known as a “worldwide” system of taxation, rather than the “territorial” system used by most other countries.  What this means is that the US taxes its resident companies on their worldwide income (with a credit or partial credit for taxes properly paid to other countries), rather than just taxing US companies on profits earned from sales derived from US customers.  US-based multinational companies often defer (indefinitely) US taxation of their profit earned outside the US by leaving it parked offshore in foreign subsidiaries; and some US companies have undertaken corporate inversion transactions in order to become non-US based and avoid the US worldwide taxation system.   There has been some talk recently of changing the rules to provide for an immediate US tax on the profits left offshore, but the greater focus appears to be on changing to a system which would greatly favor net exporters and punish net importers.

A lot of details remain to be fleshed out, but the basic concept of a border adjustment tax (BAT) is that revenue from exports would be tax-exempt, while revenue from domestic sales is subject to income tax, and the cost of goods and services purchased domestically would be tax deductible, whereas the cost of goods and services imported would be nondeductible.  Accordingly, a company importing 100% of its goods and services would pay income tax on 100% of its revenue (much like a sales tax, but at a much higher rate), whereas a company exporting 100% of its goods or services would pay no income tax (and conceivably report a huge loss for income tax purposes, even if very profitable).

So who would be the big winners and losers?  If we assume a static environment in which no one changes their behavior due to changes in tax law, then companies which tend to produce in the US but sell abroad (think Boeing, GE, Caterpillar, etc.) would be huge winners, while companies which import much of what they sell (think big retailers like Wal-Mart) would be significantly harmed. Companies which operate almost entirely domestically (both in terms of revenues and costs) would theoretically not be impacted (except to the extent they enjoyed the anticipated cut in the tax rate).

Realistically, we do not operate in a static environment.  Importers would, of course, attempt to pass this new cost along to their customers (some larger retailers have estimated this would result in price increases of 15%); and consumers might then reduce their spending.  A BAT would most likely violate World Trade Organization (WTO) rules, and our trading partners would likely retaliate by slapping tariffs on goods and services imported from the US; potentially resulting in a trade war. Also, other countries might not honor the tax treaties we have entered into which serve to protect US companies and individuals from double taxation.  As Sir Isaac Newton said, for every action, there is an equal and opposite reaction.

While a BAT could become the backbone of tax reform, it seems at least as likely to become the impediment to getting any tax reform done.  It seems likely that few if any Democrats will support it, and there will likely be some Republican opposition as well (e.g. Republican Senator Tom Cotton from Arkansas, home of Wal-Mart, has referred to the theory that a BAT would strengthen the US dollar as “a theory wrapped in speculation inside a guess”).  Cynics might say that talk of a BAT is just a fundraising bonanza for members of the House and Senate tax-writing committees; and deep-pocketed groups have certainly lined up on either side of this proposal.

Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.

This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice.  The article provides only a very general summary of complex rules.  For advice on how these rules may apply to your specific situation, contact a professional tax advisor.